Question 1

When yield curves are downward sloping
A)long-term interest rates are above short-term interest rates.
B)short-term interest rates are above long-term interest rates.
C)short-term interest rates are about the same as long-term interest rates.
D)medium-term interest rates are above both short-term and long-term interest rates.

Accepted Answer

Downward sloping yield curves, also known as inverted yield curves, indicate that short-term interest rates are higher than long-term interest rates. This is often seen as a signal of a possible economic downturn or recession.

Question 2

If the expected path of 1-year interest rates over the next five years is 2 percent,4 percent,1 percent,4 percent,and 3 percent,the expectations theory predicts that the bond with the lowest interest rate today is the one with a maturity of
A)one year.
B)two years.
C)three years.
D)four years.

Accepted Answer

According to the expectations theory, the interest rate on a bond is determined by the average of expected future short-term interest rates. The one-year bond will have the lowest interest rate today because it only reflects the first year's expected rate of 2 percent, which is the lowest among the given expected rates.

Question 3

If the expected path of 1-year interest rates over the next four years is 5 percent,4 percent,2 percent,and 1 percent,then the expectations theory predicts that today's interest rate on the four-year bond is
A)1 percent.
B)2 percent.
C)3 percent.
D)4 percent.

Accepted Answer

The expectations theory suggests that the long-term interest rate for a bond is the geometric average of short-term interest rates expected over the same time period. So, the four-year bond rate will be the average of the four one-year interest rate expectations: [(1+2+4+5)/4] = 3 percent. Therefore, the correct answer is C) 3 percent.

Question 4

The typical shape for a yield curve is
A)gently upward sloping.
B)mound shaped.
C)flat.
D)bowl shaped.

Accepted Answer

The typical shape for a yield curve is gently upward sloping, indicating that longer-term bonds have higher yields than shorter-term bonds.

Question 5

Over the next three years,the expected path of 1-year interest rates is 4,1,and 1 percent. The expectations theory of the term structure predicts that the current interest rate on 3-year bond is
A)1 percent.
B)2 percent.
C)3 percent.
D)4 percent.

Accepted Answer

The expectations theory of the term structure suggests that the yield on a longer-term bond will equal the geometric average of short-term interest rates expected to prevail over the life of the long-term bond. Here, the average of the expected 1-year interest rates over the next three years (4%, 1%, 1%) is calculated as the geometric mean: [(1.04 * 1.01 * 1.01)^(1/3)] - 1 ≈ 2%. Therefore, the current interest rate on a 3-year bond, according to the expectations theory, would be approximately 2%.

Question 6

Economists' attempts to explain the term structure of interest rates
A)illustrate how economists modify theories to improve them when they are inconsistent with the empirical evidence.
B)illustrate how economists continue to accept theories that fail to explain observed behavior of interest rate movements.
C)prove that the real world is a special case that tends to get short shrift in theoretical models.
D)have proved entirely unsatisfactory to date.

Accepted Answer

Economists have modified their theories over time to more accurately explain the term structure of interest rates based on empirical evidence. This demonstrates how economists refine their theories to improve their accuracy in explaining real-world phenomena.

Question 7

According to the expectations theory of the term structure
A)when the yield curve is steeply upward sloping,short-term interest rates are expected to remain relatively stable in the future.
B)when the yield curve is downward sloping,short-term interest rates are expected to remain relatively stable in the future.
C)investors have strong preferences for short-term relative to long-term bonds,explaining why yield curves typically slope upward.
D)yield curves should be equally likely to slope downward as slope upward.

Accepted Answer

The expectations theory of the term structure suggests that the shape of the yield curve reflects investors' expectations about future interest rates. If investors expect future short-term rates to rise, the yield curve will slope upward; if they expect rates to fall, it will slope downward. The theory does not inherently favor upward or downward sloping curves, implying that both are equally likely depending on future interest rate expectations.

Question 8

When yield curves are steeply upward sloping
A)long-term interest rates are above short-term interest rates.
B)short-term interest rates are above long-term interest rates.
C)short-term interest rates are about the same as long-term interest rates.
D)medium-term interest rates are above both short-term and long-term interest rates.

Accepted Answer

Steep upward-sloping yield curves indicate that long-term interest rates are higher than short-term interest rates. This is because lenders demand higher compensation for lending their money for a longer period of time.

Question 9

The spread between the interest rates on Baa corporate bonds and U.S. government bonds is very large during the Great Depression years 1930-1933. Explain this difference using the bond supply and demand analysis.

Accepted Answer

The answer of The spread between the interest rates on...

Question 10

If the expected path of one-year interest rates over the next five years is 4 percent,5 percent,7 percent,8 percent,and 6 percent,then the expectations theory predicts that today's interest rate on the five-year bond is
A)4 percent.
B)5 percent.
C)6 percent.
D)7 percent.

Accepted Answer

The expectations theory states that the long-term interest rates are the geometric average of expected future short-term rates. In this case, the average of the expected one-year interest rates is:

(1.04 x 1.05 x 1.07 x 1.08 x 1.06)^(1/5) -1 = 1.077 - 1 = 0.077 or 7.7%.

Therefore, today's interest rate on the five-year bond is expected to be 7 percent, which is closest to (C) 6 percent.

Question 11

If the expected path of 1-year interest rates over the next five years is 1 percent,2 percent,3 percent,4 percent,and 5 percent,the expectations theory predicts that the bond with the highest interest rate today is the one with a maturity of
A)two years.
B)three years.
C)four years.
D)five years.

Accepted Answer

According to the expectations theory, the bond with the highest interest rate will be the one with the longest maturity, as it compensates investors for locking in their money for a longer period of time. Therefore, the bond with a maturity of five years will have the highest interest rate in this scenario.

Question 12

When yield curves are flat
A)long-term interest rates are above short-term interest rates.
B)short-term interest rates are above long-term interest rates.
C)short-term interest rates are about the same as long-term interest rates.
D)medium-term interest rates are above both short-term and long-term interest rates.

Accepted Answer

Flat yield curves indicate that short-term interest rates are about the same as long-term interest rates. This means that investors are not expecting significant changes in monetary policy or inflation in the near future.

Question 13

According to the expectations theory of the term structure,the interest rate on a long-term bond will equal the ________ of the short-term interest rates that people expect to occur over the life of the long-term bond.
A)average
B)sum
C)difference
D)multiple

Accepted Answer

According to the expectations theory of the term structure, the interest rate on a long-term bond will equal the average of the short-term interest rates that people expect to occur over the life of the long-term bond. This means that the long-term interest rate is an average of expected short-term rates.

Question 14

Differences in ________ explain why interest rates on Treasury securities are not all the same.
A)risk
B)liquidity
C)time to maturity
D)tax characteristics

Accepted Answer

The time to maturity of Treasury securities will affect their interest rates. Typically, longer-term securities will have higher interest rates than shorter-term securities.

Answer: A, B, D
 Risk, liquidity, and tax characteristics can also impact the interest rates on Treasury securities. Securities with higher risk, less liquidity, or less favorable tax characteristics will generally have higher interest rates to compensate investors for the additional risk or inconvenience.

Question 15

If the federal government where to raise the income tax rates,would this have any impact on a state's cost of borrowing funds? Explain.

Accepted Answer

The answer of If the federal government where to raise...

Question 16

An inverted yield curve
A)slopes up.
B)is flat.
C)slopes down.
D)has a U shape.

Accepted Answer

An inverted yield curve slopes down, indicating that short-term interest rates are higher than long-term interest rates. This is considered a predictor of an upcoming recession as it suggests that investors are more interested in the short-term safety of their investments rather than long-term growth potential.

Question 17

According to the expectations theory of the term structure
A)the interest rate on long-term bonds will exceed the average of short-term interest rates that people expect to occur over the life of the long-term bonds,because of their preference for short-term securities.
B)interest rates on bonds of different maturities move together over time.
C)buyers of bonds prefer short-term to long-term bonds.
D)buyers require an additional incentive to hold long-term bonds.

Accepted Answer

The expectations theory of the term structure suggests that interest rates on bonds of different maturities move together over time, based on the expected future short-term interest rates. This theory assumes that investors are indifferent between short-term and long-term bonds and that the only difference in rates between them is due to the expected path of short-term interest rates. Therefore, choice A, C, and D are incorrect.

Question 18

If bonds with different maturities are perfect substitutes,then the ________ on these bonds must be equal.
A)expected return
B)surprise return
C)surplus return
D)excess return

Accepted Answer

If bonds with different maturities are perfect substitutes, investors would only consider their expected returns when deciding which bond to invest in. The surprise return, surplus return, and excess return would not matter because they do not differentiate between the bonds based on their maturities. Therefore, the expected return on these bonds must be equal.

Question 19

The term structure of interest rates is
A)the relationship among interest rates of different bonds with the same maturity.
B)the structure of how interest rates move over time.
C)the relationship among the term to maturity of different bonds.
D)the relationship among interest rates on bonds with different maturities.

Accepted Answer

The term structure of interest rates refers to the relationship among interest rates on bonds with different maturities. This is often represented graphically as a yield curve, which shows the yield (or interest rate) on bonds of different maturities. The shape of the yield curve can provide insight into market expectations for future interest rates and inflation.

Question 20

A plot of the interest rates on default-free government bonds with different terms to maturity is called
A)a risk-structure curve.
B)a default-free curve.
C)a yield curve.
D)an interest-rate curve.

Accepted Answer

A plot of the interest rates on default-free government bonds with different terms to maturity is called a yield curve. It is a graphical representation of the relationship between bond yields and maturities. The yield curve shows the prevailing market expectation for future interest rates and inflation.

Quiz 6: The Risk and Term Structure of Interest Rates

When yield curves are downward sloping

If the expected path of 1-year interest rates over the next five years is 2 percent,4 percent,1 percent,4 percent,and 3 percent,the expectations theory predicts that the bond with the lowest interest rate today is the one with a maturity of

If the expected path of 1-year interest rates over the next four years is 5 percent,4 percent,2 percent,and 1 percent,then the expectations theory predicts that today's interest rate on the four-year bond is

The typical shape for a yield curve is

Over the next three years,the expected path of 1-year interest rates is 4,1,and 1 percent. The expectations theory of the term structure predicts that the current interest rate on 3-year bond is

Economists' attempts to explain the term structure of interest rates

According to the expectations theory of the term structure

When yield curves are steeply upward sloping

The spread between the interest rates on Baa corporate bonds and U.S. government bonds is very large during the Great Depression years 1930-1933. Explain this difference using the bond supply and demand analysis.

If the expected path of one-year interest rates over the next five years is 4 percent,5 percent,7 percent,8 percent,and 6 percent,then the expectations theory predicts that today's interest rate on the five-year bond is

If the expected path of 1-year interest rates over the next five years is 1 percent,2 percent,3 percent,4 percent,and 5 percent,the expectations theory predicts that the bond with the highest interest rate today is the one with a maturity of

When yield curves are flat

According to the expectations theory of the term structure,the interest rate on a long-term bond will equal the ________ of the short-term interest rates that people expect to occur over the life of the long-term bond.

Differences in ________ explain why interest rates on Treasury securities are not all the same.

If the federal government where to raise the income tax rates,would this have any impact on a state's cost of borrowing funds? Explain.

An inverted yield curve

According to the expectations theory of the term structure

If bonds with different maturities are perfect substitutes,then the ________ on these bonds must be equal.

The term structure of interest rates is

A plot of the interest rates on default-free government bonds with different terms to maturity is called